As a result of the UK government’s 2050 net zero goals, changes in government policy and building regulations will put significant pressure on owners of real estate to improve the sustainability of their buildings.
Additionally, the embodied carbon (emissions produced through the materials and construction process employed on the site) held in existing properties is considerable and retrofitting often presents a considerable carbon saving relative to demolishing and rebuilding.
Legislation introduced in 2018 set a minimum energy efficiency standard (MEES) for non-domestic buildings to achieve a set level of energy efficiency. Benchmarked through EPCs (energy performance certificates), the legislation requires properties to hold an EPC grade of E or above in order to be let or sold. In 2023, the grade E requirement will be extended to all non-domestic properties including those under lease, unless a valid MEES exemption has been registered.
According to our analysis of the EPC register, the 2023 MEES will impact 9,900 industrial properties, around 10% of buildings, that were graded at F or G between 2012 and 2021. In 2030, the MEES requirement will increase further with all non-domestic properties needing to achieve an EPC grade B or above unless holding an exemption. Based on EPC lodgements since 2012, this will require in excess of 89,900 or 90% of industrial properties to improve their energy performance – a considerable task.
Recommendations for improving the energy performance of a building are provided with each EPC. While some of these are relatively simple and affordable, such as changing the lightbulbs for low-energy alternatives, others are much more invasive and cost intensive.
IN IT TOGETHER
Ultimately, landlords and owners are responsible for ensuring their buildings meet the MEES requirements, even if the property is under a full repairing and insuring lease. Completing the necessary works to achieving the standard may cause tensions between occupiers and landlords as the tenant is unlikely to want to sacrifice their access for works to take place. Temporary exemptions are stipulated in the legislation to help navigate these challenges, but we are likely to see landlords being obliged to take advantage of lease events to ensure changes are enacted as soon as possible in order to avoid breaching requirements.
In addition to this, tenants making large investments into their buildings, including, heat pumps, PV (photovoltaics) arrays and batteries, are likely to wait for expected business rates tax amendments. This is to avoid risking an inadvertent increase in business rates liabilities, as making certain energy efficiency improvements can result in higher valuations, triggering a rise in rates payable, although this discrepancy is expected to be amended in April 2023, it is currently acting as a barrier to investment in decarbonising stock and may mean some buildings do not receive the current investment they need to avoid legislative obsolescence.
Some landlords may attempt to gain rolling five-year exemptions based on technicalities, but we expect the government to make this increasingly onerous and costly, notwithstanding the reputational risk this could exert on the building owner or operator.
This widespread risk of obsolescence will help contribute to liquidity in the market as savvy investor/developers look to leverage this risk to acquire discounted stock for retrofit or redevelopment.
THE SEVEN YEAR (GL)ITCH?
There is an additional exemption for retrofitting improvements that will take longer than seven years to recoup the initial cost of the work through estimated savings in energy bills. The formula for the seven-year payback test is set out in regulation and obtaining an exemption along with cost quotations requires evidence of the calculations made to demonstrate this. This MEES exemption route also requires a confirmation that the landlord or a person exercising management control in relation to the landlord is satisfied that it does not meet the seven-year payback rule.
Although this is intended to make the sustainable transition more equitable, building owners remain responsible for conducting and financing the often-considerable retrofitting works needed, even if they do not occupy the building themselves and hence will only be passing on the energy saving to the tenant.
The seven year exemption also means that a large proportion of non-domestic properties will not be required to meet the energy efficiency level needed for the UK to achieve the 2050 net zero carbon target. We therefore expect the exemption to be amended or dissolved in the future to ensure MEES are able to generate the level of change needed.
UNDER OPERATION
A further stick the government has up its sleeve to corral the real estate sector onto the road to net zero is the widespread introduction of operational energy performance standards. These would measure a building’s actual energy performance annually and allow for a much more accurate and up-to-date assessment of its performance. The introduction of a performance-based policy framework and rating system will be introduced for buildings over 1,000 sq m in England and Wales. The details are still being fleshed out, but initially it will be applied to offices before being expanded to other asset types, with industrial buildings being high up the priority list.
The 2023 MEES will impact 9,900 industrial properties, around 10% of buildings, that were graded at F or G between 2012 and 2021.